The business process outsourcing has seen an unprecedented growth in India. India is being perceived as the BPO destination of the world.

At a time when BPO activities in India is projected to touch $3.6 billion in the current year and $13.8 billion in three years, this sector needs fiscal encouragement as well as political protection.

On January 2, the Central Board of Direct Taxes in a circular No. 1 of 2004 has laid down the circumstances under which BPO units will attract tax in India.

As per the circular, when a foreign firm outsources the whole or part of its core revenue generating business activities to an IT-enabled entity in India, and entity renders services to customers abroad, a considerable portion of the profit derived by the foreign firm from its customers abroad will be attributable to the activities performed by the IT-enabled entity in India. Such profit will be liable to tax in India in accordance with the Income Tax Act or the relevant tax treaty.

The circular, however, clarified that the question of tax in India would arise only when the BPO unit created a "permanent establishment" in India.

The circular also said if the BPO activity generated insignificant profit, which was difficult to determine, there would be no tax in India except on the direct income of the BPO unit. According to the circular, BPO activities in India should not attract any tax on foreign company's income through the Indian BPO units, in the following cases:

• Where a non-resident carries on manufacture and sale of goods or merchandise or provision of services outside India, but outsources some of its incidental activities.
• Where a foreign firm manufacturing computers abroad and also selling such computers to customers abroad, engages or sets up a call centre in India to procure orders from or conclude contracts with customers abroad and to answer sales related queries on telephone.
• Where a foreign insurance firm insuring risks in countries other than India appoints or sets up a call centre in India to attend to calls from customers outside India, while actual policy issuance as well as collection of premium is done outside India.
• Where a foreign credit card company issuing credit cards to customers in countries other than India appoints or sets up a call centre in India to attend to the calls of customers, while the actual card issue, the delivery of the card and collection of charges is done outside India.

In these cases, no effort will be made to allocate any profit derived by the foreign enterprise from its customers abroad to the Indian BPO unit provided that the charges paid to the Indian BPO unit for its services are at arm's length/fair market price. The Indian BPO unit will of course be liable to pay tax in India on its direct profits.

On the other hand, the CBDT considers that a considerable portion of the profits derived by the foreign firm from their customers abroad will be attributable to the activities performed by the IT-enabled entity in India for services relating to travel agents software developers, software maintenance, investment consultants and debt collection.

The circular, however, specifies that the tax in India will become chargeable only where the foreign firm outsources the whole or part of its core revenue generating business activities to India, and further if the Indian BPO unit constitutes the foreign enterprises' permanent establishment in India as per the provisions of the relevant tax treaty.

An analysis of the circular reveals that it neither lays down any new law nor clarifies as to how taxable income, if any, will be determined. It only says where tax is to be levied, it will be done as per the provisions of Income Tax Act or the relevant tax treaty.

This circular is more likely to add to the prevailing confusion, which will only dissuade foreign firms to set-up BPO units in India.